Today’s Blog – Thursday 11th August 2016

In recent times we have sourced a few quotes from the likes of finance industry gurus Bill Gross and Jeremy Grantham commenting on the current, completely unprecedented, low interest rate environment.

What Grantham has referred to as the “black hole” effect – the laws of physics/finance are being warped – also are being manifest in the oil and gas sector – and indeed could be as influential as any normal supply/demand factor on current oil markets.

For instance, the ongoing resilience of US tight oil production – the ostensible enemy of OPEC that was going to be smashed by the latter’s decision to not cut production in late 2014 – is greatly supported by both the low cost of debt – and the corresponding desperate search for any type of yield by equity and debt investors.

The larger independents in particular seem to still be able to persuade investors to supply them with almost never-ending funds in a ~US$40 oil price environment. The result is that US oil production has only fallen by ~1 mmbopd in the last 18 months.

At the Super-Major end of the oil patch, the demand for yield by investors is almost the key driving factor in how these large companies are behaving. That is, dividend maintenance is king – capex, opex, head-count (let alone growth), etc, are all sacrificed on that altar.

Looked at from afar, that is not rational. Equity investors should be first to receive a smaller slice of a diminishing cash-flow pie. However, the fact that investors can’t get a return from bonds means that they effectively point a gun at big company Boards over their now sacrosanct dividends.

The results from these two warpings of normal behaviour pull in opposite directions – higher than expected US oil production at present – lower (much lower?) oil production from the Majors in the “medium” term.

Commodity prices

Crude prices fell over-night, with Brent down ~2.6% to US$43.85 and WTI down a similar percentage to US$41.71.

The weekly EIA report “numbers” were not well received – an unseasonal build in crude inventories of 1.1 mmbbls. The product numbers so focused on in recent weeks were in fact bullish – a gasoline draw of 2.8 mmbbls and a distillate draw of 2.6 mmbbls, but could not excite the market yesterday.

Record Saudi production just announced did not help.

Henry Hub fell again, closing down 1.5% to US$2.57.

LNG and international gas

Japan’s official (METI) LNG spot prices contracted for the country in July were published earlier this week and showed a rise to US$5.80/mmbtu – still well below what nearly all LNG projects require for an economic return.

Governments, fracking, etc

We noted yesterday the adoption by Western Australia’s supposedly conservative National Party of a Jeremy Corbyn-esque policy of breaking contracts and imposing higher taxes on iron ore production.

The occasional clod-hopping nature of the intended target of this expropriation – the mining giants BHP and Rio – was demonstrated in a news story today which shows why they are vulnerable to such populism.

This was a move by BHP to unilaterally extend its payment terms to suppliers to its WA iron ore operations. That will save BHP a tiny amount of interest (note to the Big Australian – see our editorial above) – but provide ample fuel to the fire of those saying “you deserve to pay A$Bs in more taxes”.

Of course the miners are not alone in such tactics – the oil and gas industry does not help its broad battles over issues such as accessing CBM resources in New South Wales by nickel and diming local suppliers, etc, in the search for “productivity” savings and “lower costs per barrel”.

Company news – AGL

AGL released its annual results yesterday. These noted its plans were to divest all of its remaining upstream gas assets in FY 2017. The composition of these assets are of low quality – and to us demonstrate one of our continual themes: people respond to incentives and if those incentives are poor, poor outcomes result.

A few years ago AGL had the very blunt public aim of increasing its upstream gas reserves. Result: it did – but the reserves acquired were of low quality, low (negative?) margins and of limited (zero?) synergistic value with the rest of its assets. But the outcome for Management: bonuses all round.

Not coincidentally, AGL’s Director with an upstream background, Bruce MacKay, has retired and is being replaced by someone with banking/structured finance/etc skills.

Quote of the day

From UK based blogger Euan Mearns, a similar theme to our editorial above about tight oil and the Majors pulling in different directions:

“Shale oil has certainly been a disruptive game changer. Designed to provide cheap home grown energy for the USA, the unintended consequences might be to spread more revolution in the MENA region and OPEC and to mortally wound the IOCs that have been the backbone of the OECD industry for many decades.”